Indu Rawat

United States Tax Court

T.C. Memo. 2023-14

INDU RAWAT,
Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE,
Respondent

—————

Docket No. 15340-16. Filed February 7, 2023.

—————

P, a nonresident alien, was a partner in IV LLC, a
U.S. partnership for federal income tax purposes. In 2008
(i.e., before the 2017 effective date of I.R.C. § 864(c)(8)),
P sold her interest in IV LLC, and $6.5 million of the
proceeds of that sale (“Inventory Gain”) was “attributable
to . . . inventory items” for purposes of I.R.C. § 751(a)(2).
P moved for summary judgment on the grounds that the
entire proceeds of the sale (including the Inventory Gain)
are treated under I.R.C. § 741 as gain from the sale of a
capital asset, are further treated as income from the sale of
personal property under the general rule of I.R.C.
§ 865(a)(2), and are therefore non-U.S.-source income on
which P is not taxed.

Held: Because the Inventory Gain was attributable
to inventory items for purposes of I.R.C. § 751(a)(2), it is
excepted from the general rule of I.R.C. § 741; it is, for
purposes of the sourcing rules, “income derived from the
sale of inventory property” under the exception of
I.R.C. §865(b); and it may therefore be U.S.-source income.
P’s motion for summary judgment will be denied.

—————

Served 02/07/23
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[*2] Christopher S. Rizek and Nathan J. Hochman, for petitioner.

H. Barton Thomas and S. Katy Lin, for respondent.

MEMORANDUM OPINION

GUSTAFSON, Judge: This case involves the federal income tax
consequences for a nonresident alien individual upon the sale of her
interest in a U.S. partnership when a portion of the sale proceeds is
attributable to inventory items of the partnership held for sale in the
United States. At issue are the years 2008 and 2009, for which the
Internal Revenue Service (“IRS”) issued to petitioner, Indu Rawat, a
statutory notice of deficiency (“NOD”). She filed a petition in the Court
pursuant to section 6213(a)1 and claimed an overpayment pursuant to
section 6512(b). Now pending before the Court is Ms. Rawat’s motion
for summary judgment. Doc. 32. The motion asserts two issues: first, a
so-called “Non-Inventory Gain issue” that the Commissioner now
concedes, see Docs. 54–55, and second, an “Inventory Gain issue” that
we address in this Opinion. Potential U.S.-source income inheres in
inventory that a partnership holds for sale in the United States, and
when that inventory is later sold, U.S.-source income may be realized.
However, a foreign partner who sells her partnership interest before
that inventory gain is realized thereby receives compensation for the
value of that inventory but might avoid U.S. taxation on her receipt of
that value. Ms. Rawat asks us to hold that she is not liable for U.S.
federal income tax on the Inventory Gain as a matter of law. We will
deny her motion.

Background

The facts pertinent to Ms. Rawat’s motion are not in dispute, and
they can be stated briefly as follows.

1 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C., as in effect at the relevant times; regulation references are to
the Code of Federal Regulations, Title 26 (Treas. Reg.), as in effect at the relevant
times; and Rule references are to the Tax Court Rules of Practice and Procedure. Some
dollar amounts are rounded. Parenthetical references to “Doc.” are to documents as
they are numbered in the docket record of this case, and the page numbers cited in
those references are according to the numbering in the portable document format
(“PDF”) of the digital file.
 3

[*3] Petitioner and her partnership interest

Ms. Rawat was a nonresident alien individual for federal income
tax purposes during 2008 and 2009. She filed U.S. federal income tax
returns as a nonresident alien for the 2000 through 2007 tax years. She
did not file returns for the 2008 and 2009 tax years.

Innovation Ventures, LLC (“IV LLC”), is a U.S. business that
manufactures and sells popular consumer products including 5-hour
Energy drinks. IV LLC was treated as a partnership for federal income
tax purposes during the years at issue.

Between December 2000 and January 2007, Ms. Rawat acquired
a 30% interest in IV LLC. On January 4, 2008, Ms. Rawat executed a
note for the sale of her interest in IV LLC to Manoj Bhargava for
$438 million. The note provided for interest-only payments to
Ms. Rawat until 2028, when the note would mature.

At the time the note was executed, IV LLC had inventory items
with a basis of $6.4 million, which it held for future sale in the United
States. 2 IV LLC later sold those inventory items for a profit of
$22.4 million, and Ms. Rawat admits that her share of income
“attributable to the inventory” was $6.5 million (an amount agreed to by
Ms. Rawat and the IRS, as explained below). Thus, of the $438 million
sale price paid to Ms. Rawat (by the note from Mr. Bhargava) for her
interest in IV LLC, $6.5 million was allocable to inventory held in the
United States for sale therein (“Inventory Gain”).

Partnership examination and Form 5701

The IRS conducted an examination of IV LLC for the 2007 and
2008 tax years. In December 2010 the IRS issued Form 5701, “Notice of
Proposed Adjustment”, Doc. 40, Ex. 4, to IV LLC and to Ms. Rawat. The
Form 5701 proposed to include in Ms. Rawat’s income for 2008
$6.5 million arising from the Inventory Gain issue.

2 The record does not show whether the inventory would be sold within or

without the United States, so for purposes of deciding Ms. Rawat’s motion for summary
judgment (in which context we assume facts and draw inferences in favor of the non-
movant, see infra Part I.A) we assume (in the Commissioner’s favor) that the inventory
was for sale in the United States (thus potentially yielding U.S.-source income, see
infra Part II.B).
 4

[*4] Agreement on Form 870–LT

Consistent with the Form 5701, Ms. Rawat executed with the IRS
Form 870–LT, “Agreement for Partnership Items and Partnership Level
Determinations as to Penalties, Additions to Tax, and Additional
Amounts and Agreement for Affected Items”. Doc. 40, Ex. 3. A
“Schedule of Adjustments” attached to the Form 870–LT includes, under
“Other income (loss)”, an adjustment of $6,523,176, with the explanation
that “[o]ther income relates to unrealized receivables[3] as defined under
Section 751.” In February 2011 Ms. Rawat signed the Form 870–LT,
and in April 2011 the IRS countersigned. As we previously held, 4 Ms.
Rawat and the IRS did not reach agreement about the “source” (whether
U.S. or non-U.S.) of the $6.5 million of income nor about Ms. Rawat’s
ultimate tax liabilities for the 2008 and 2009 tax years.

Notice of Computational Adjustment

In February 2012 the IRS issued to Ms. Rawat a Notice of
Computational Adjustment for her 2008 tax year. Doc. 40, Ex. 6. The
text of the notice indicates that “[t]he adjustments are being made as a
result of” several possible alternatives, including “an agreement you
signed”, and a copy of the Form 870–LT agreement was attached. The
notice included Form 4549–A, “Income Tax Discrepancy Adjustments”,
that listed a $6.5 million increase in income for “Sch E - Inc/Loss -
Partnership - Innovation Ventures LLC” (i.e., the Inventory Gain issue
addressed in the Form 870–LT) and a tax liability of $2.3 million.
Additionally, the IRS determined nearly $1 million in additions to tax
under section 6651(a)(1) and (2) and section 6654.

3 The Commissioner plausibly explains (and we assume) that the reference in
the “Remarks” to “unrealized receivables” is a “scrivener’s error” that should instead
refer to inventory.
4 Our order of July 28, 2022, Doc. 70, stated:
The Form 870–LT determined adjustments to ‘ordinary income’ and
‘other income’ (relating to the inventory gain), among other income
items and deductions, but specifically lacked a determination as to the
source of the income or as to Ms. Rawat’s deficiency and corresponding
tax liability. (Doc. 5 at 26–28). Neither the source of the income, nor
Ms. Rawat’s deficiency, nor her tax liability were ‘matters agreed upon’
within the meaning of section [7121] and we may not read them into
the agreement. Zaentz v. Commissioner, 90 T.C. [753,] 761, 766 (1988).
Therefore, we find that the parties did not agree to these items in the
Form 870–LT, and that the source of the inventory gain Ms. Rawat
recognized on the sale of her partnership interest remains at issue.
 5

[*5] In March 2012 the IRS assessed these amounts (though they were
later reduced to reflect a $1.9 million charitable contribution deduction
carryover from the prior year).

Statutory notice of deficiency and petition

In May 2016 the IRS issued to Ms. Rawat an NOD for her 2008
and 2009 tax years. Doc. 1, Ex. A. The NOD reflected the previously
determined income for 2008 (from the Inventory Gain issue, as stated in
the Notice of Computational Adjustment) and further determined
additional taxes owed by Ms. Rawat under section 453A(c)(2)(B) as
interest on the deferred tax liability attributable to the installment
obligation (i.e., Mr. Bhargava’s note for his purchase of Ms. Rawat’s
partnership interest in IV LLC) for both 2008 and 2009 (“Non-Inventory
Gain”). Doc. 55, para. 4. The NOD indicated a $3.8 million deficiency
in tax for 2008 and a $2.6 million deficiency in tax for 2009. Altogether,
the deficiencies in tax and additions to tax totaled $4.8 million for 2008
and $3.8 million for 2009.

In June 2016 Ms. Rawat paid $2.9 million in tax, interest, and
additions to tax attributable to the initial assessments for the 2008 tax
year (i.e., arising from the computational adjustments for the Inventory
Gain issue). In July 2016 Ms. Rawat filed her petition with this Court
in order to challenge the items in the NOD and to invoke the Court’s
overpayment jurisdiction under section 6512(b) with respect to her
$2.9 million payment for the computational adjustment. Her petition
alleges an address in Singapore.

Petitioner’s motion for summary judgment

Ms. Rawat’s motion for summary judgment, Docs. 32, 33,
contends that the opinions of this Court and of the Court of Appeals for
the D.C. Circuit in Grecian Magnesite Mining, Industrial & Shipping
Co., SA v. Commissioner, 149 T.C. 63 (2017), aff’d, 926 F.3d 819 (D.C.
Cir. 2019), 5 effectively resolve both the Non-Inventory Gain issue (which
the Commissioner has since conceded) and the Inventory Gain issue
(which is still in dispute and is now before us). Ms. Rawat’s general

5 Congress effectively overruled Grecian Magnesite in the Tax Cuts and Jobs

Act of 2017, Pub. L. No. 115-97, § 13501(a)(1), 131 Stat. 2054, 2138–41, by adding to
the Code section 864(c)(8), effective for transactions after November 27, 2017.
Ms. Rawat sold her interest in IV LLC in 2008, before the effective date of
section 864(c)(8), so in resolving her motion we follow Grecian Magnesite without
regard to section 864(c)(8).
 6

[*6] position is that, under Grecian Magnesite, a nonresident alien
individual is not subject to U.S. income tax on the sale of the individual’s
interest in a U.S. partnership because those gains would be sourced
outside the United States under the general rule of section 865(a)(2),
irrespective of whether any portion of the gains would be attributable to
inventory items under section 751(a)(2). Ms. Rawat contends that,
under the rationale of this Court’s decision in Grecian Magnesite, her
nonresident status resolves in her favor both the Inventory Gain and the
Non-Inventory Gain issues.

Respondent’s response

The Commissioner did not file a cross-motion for summary
judgment but opposes Ms. Rawat’s motion on the ground 6 that the
sourcing of the Inventory Gain must be made under the rules of
section 865(b), as to which Ms. Rawat has not yet made a showing.

Discussion

I. General legal principles

A. Summary judgment

Under Rule 121(b), summary judgment is appropriate if there is
no genuine dispute as to any material fact and a decision may be
rendered as a matter of law. See also Sundstrand Corp. v.
Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994);
Naftel v. Commissioner, 85 T.C. 527, 529 (1985). The moving party
bears the burden of showing that no such genuine dispute exists and
that she is entitled to judgment on the substantive issues as a matter of
law. Celotex Corp. v. Catrett, 477 U.S. 317, 323 (1986); Espinoza v.
Commissioner, 78 T.C. 412, 416 (1982). In deciding whether to grant
summary judgment, we draw inferences in favor of the nonmoving
party. Anderson v. Liberty Lobby Inc., 477 U.S. 242, 255 (1986); Naftel,

6 The Commissioner’s opposition also included two contentions that we do not

address here: First, the Commissioner contended that the agreement on Form 870–LT
executed by the parties resolves the disputed Inventory Gain issue in his favor, but we
decided that issue against the Commissioner in a previous order. Doc. 70; see supra
note 4. Second, the Commissioner originally contended that a genuine dispute of
material fact as to whether Ms. Rawat was a nonresident alien in 2008 and 2009
precludes summary judgment on the Inventory Gain issue; but since then he has
stipulated that she was a nonresident alien in 2008. See Doc. 71.
 7

[*7] 85 T.C. at 529. If any genuine dispute of fact exists, the motion
must be denied. Espinoza, 78 T.C. at 416.

Ms. Rawat has moved for summary judgment, so she has the
burden to show that there are no material facts in dispute and that she
is entitled to judgment on the substantive issues as a matter of law.

B. Partnership taxation in an international context

This case, like Grecian Magnesite, 149 T.C. at 71, “arises at the
intersection of two areas of tax law—i.e., partnership taxation
(subchapter K of the Code) and U.S. taxation of international
transactions (subchapter N of the Code).” That is, we address the U.S.
federal income tax treatment of a nonresident alien’s sale of her interest
in a U.S. partnership.

1. A partnership interest as a singular capital asset

It may assist our discussion of Ms. Rawat’s sale of her interest in
IV LLC to give a simplified description of the legal context in which the
current dispute arises. To survey that context, we can broadly describe
several forms in which a taxpayer might own a business:

First, she might own a business as a sole proprietor. She would
directly own each of the assets used in the business—its inventory to be
sold, its assets used in the business, its cash in the bank, and so on. She
would report the business’s revenue, deductions, and income or loss on
Schedule C, “Profit or Loss From Business”, attached to her individual
income tax return. If she sold the business, she would do so by selling
its assets; and she would have to account for her gain or loss on each of
those assets—whether capital assets, depreciable property or real
property used in the business, or inventory.

Second, the business might be incorporated, and the owner would
not directly own corporate assets but would instead own shares of stock
in the corporation. The corporation is recognized as a legal person
distinct from its owners. The corporation (and not the owner) would
directly own the assets of the business. The corporation would report
its revenue, deductions, and income or loss on its own corporate income
tax return, on which it would report its own income tax liability. The
owner would not report on her individual tax return any portion of the
corporation’s revenue and deductions as such but would instead report
(on Schedule B, “Interest and Ordinary Dividends”), any dividends that
she received from the corporation. The owner could sell her interest in
 8

[*8] the corporation by selling her shares, and then on her individual
tax return she would report on Schedule D, “Capital Gains and Losses”,
her gain or loss on the sale of the shares. In reporting that gain or loss
on the sale of her stock, she would not account for the underlying items
of gain or loss of the corporation nor attribute her proceeds to the various
assets of the corporation. Rather, she owned stock; she sold stock; and
she reports her gain or loss on the sale of the stock.

Third, as in this case, the business might be a partnership (or be
treated as a partnership), and the taxpayer might be a partner who owns
an interest in the partnership. For income tax purposes a partnership
has some resemblance to a corporation, but in some respects it is treated
as a confederation or aggregation of its partners. The partnership is not
itself subject to the income tax, see § 701, but instead each partner
separately reports on her individual income tax return her share of the
partnership’s taxable income or loss, see § 702(a), and the partnership’s
income is taxable to her to the extent of her distributive share, see
§ 702(c). That reporting can be thought of as roughly analogous to the
sole proprietor’s reporting on Schedule C.

However, if the owner of a partnership interest sells that interest,
then we consult sections 741 and 751 (discussed below in Part II.A) to
determine the income tax treatment of that sale. Generally speaking,
under section 741 her gain or loss “shall be considered as gain or loss
from the sale or exchange of a capital asset” (a proposition that
Ms. Rawat stresses here)—but section 741 immediately provides an
exception that the Commissioner invokes: “except as otherwise provided
in section 751 (relating to . . . inventory items).” Section 751(a)(2) in
turn provides:

The amount of any money . . . received by a transferor
partner in exchange for all or a part of his interest in the
partnership attributable to—

....

(2) inventory items of the partnership,

shall be considered as an amount realized from the sale or
exchange of property other than a capital asset.

The question now before us is whether this inventory exception
referenced in section 741 calls for distinct treatment of the inventory-
related portion of sale proceeds when the selling partner is a nonresident
 9

[*9] alien individual. That question is discussed in Part II below, but
first we describe the general principles of taxation of international
transactions.

2. U.S. “source” and “effective[] connect[ion]” with a
U.S. business

U.S. federal income tax is imposed on nonresident alien
individuals by section 871. For “Income connected with the United
States business”, subsection (b)(1) 7 of section 871 provides:

A [1] nonresident alien individual [2] engaged in trade or
business within the United States during the taxable year
shall be taxable as provided in section 1 or 55 on his taxable
income which is [3] effectively connected with the conduct
of a trade or business within the United States.

(Emphasis added.)

The parties present no dispute about the application of these
principles to most of Ms. Rawat’s income from IV LLC. In order to
address the dispute that does exist, it is helpful first to observe that
undisputed treatment.

a. Petitioner was liable for income tax on her
distributive share of IV LLC’s income.

Not at issue is Ms. Rawat’s liability for U.S. income tax on her
distributive share of IV LLC’s income, and it is clear that when she was
a partner in IV LLC she was so liable under the three conditions of
section 871(b)(1) as numbered above: First, it is stipulated that
Ms. Rawat is a nonresident alien individual. Second, section 875(1)
provides that “a nonresident alien individual . . . shall be considered as
being engaged in a trade or business within the United States if the
partnership of which such individual . . . is a member is so engaged”,
and under that provision, as a matter of law, Ms. Rawat was “engaged

7 Subsection (a)(1) of section 871 imposes tax on a nonresident alien individual

for certain income that is “not effectively connected with the conduct of a trade or
business within the United States”, see infra note 11 (fixed or determinable annual or
periodical income), but this subsection is not relied on by the Commissioner and is not
at issue here.
 10

[*10] in a trade or business within the United States”, 8 i.e., IV LLC’s
business of selling energy drinks. Third, Ms. Rawat’s distributive share
of IV LLC’s income was “effectively connected” to its U.S. energy drink
business. 9 Ms. Rawat was thus liable through 2007 for U.S. income tax
on her portion of IV LLC’s income that was effectively connected with
its energy drink business in the United States.

b. Petitioner was not liable for U.S. income tax
on most of the proceeds of the sale of her
partnership interest.

Also not in dispute is Ms. Rawat’s non-liability for U.S. income
tax on most of the proceeds of the 2008 sale of her partnership interest
for $438 million. About $431.5 million of those proceeds was
attributable to so-called Non-Inventory Gain, and the Commissioner
now concedes that that portion is not subject to U.S. income tax.

That concession is appropriate. Before the Court of Appeals for
the D.C. Circuit issued its opinion in Grecian Magnesite, the
Commissioner maintained his position, based on Rev. Rul. 91-32, 1991-1
C.B. 107, that the gain realized by a foreign partner upon disposing of
its interest in a U.S. partnership should be analyzed asset by asset and
that, to the extent that the assets of the partnership would give rise to
effectively connected income if sold by the partnership, the departing
partner’s pro rata share of such gain should likewise be treated as
effectively connected income. This Court rejected that position in
Grecian Magnesite and held that, as a general rule, the asset to be
considered in the sourcing analysis is the partnership interest itself
(which is the subject of the sale) and not the underlying partnership
assets. Section 865(a), discussed below in Part II.B, provides the
“General Rule” that “[e]xcept as otherwise provided in this section,

8 Ms. Rawat asserts, Doc. 78, para. 7, that “[t]he reasoning of” Grecian
Magnesite “is based on the principle that the taxpayer in question is not in a US trade
or business”; but in fact our opinion in that case explicitly holds that the partnership’s
“trade or business is attributed to [the partner] by section 875(1).” Grecian Magnesite,
149 T.C. at 82.
9 If a U.S. partnership has some income that is not effectively connected with

its U.S. business, then a nonresident alien partner’s share of that portion of the income
would avoid U.S. taxation by virtue of section 871(b)(2), which provides: “In
determining taxable income for purposes of paragraph (1), gross income includes only
gross income which is effectively connected with the conduct of a trade or business
within the United States.” But apparently that was not the case with IV LLC, and in
any event no such issue has arisen in this case.
 11

[*11] income from the sale of personal property . . . (2) by a nonresident
shall be sourced outside the United States.” The parties concur that a
partnership interest is “personal property” and that, for a sale in 2008, 10
the Code does not “otherwise provide[]” any relevant exception that
might be applicable to the Non-Inventory Gain portion of the proceeds
of the sale of that interest.

Still in dispute is the portion of the sale proceeds that is
attributable to Inventory Gain. We must decide whether that portion
should be treated as “effectively connected” to IV LLC’s energy drink
business in the United States.

II. Analysis

A. Characterizing the proceeds and sale under sections 741
and 751

1. Petitioner’s reliance on section 741

Ms. Rawat’s contention, stated simply, is that the Inventory Gain
portion should be treated like the Non-Inventory Gain portion, because
(she contends) neither of those portions is “effectively connected” to the
energy drink business in the United States. Section 741 provides:

In the case of a sale or exchange of an interest in a
partnership, gain or loss shall be recognized to the
transferor partner. Such gain or loss shall be considered
as gain or loss from the sale or exchange of a capital asset,
except as otherwise provided in section 751 (relating to
unrealized receivables and inventory items).

(Emphasis added.) Ms. Rawat is correct when she asserts that “the most
important point in [her] motion”, Doc. 43 at 20, is that she did not sell
inventory but instead an interest in a partnership that owned inventory.
Under section 741 Ms. Rawat’s interest in IV LLC was a singular
“capital asset”; and on the sale of that interest, she must recognize gain
or loss. As a nonresident alien, she is taxable under section 871(b)(2)
only on income that is “effectively connected with the conduct of a trade
or business within the United States”. Under section 864(c)(3), “[a]ll
income, gain, or loss from sources within the United States . . . shall be

10 For a sale on or after November 27, 2017, section 864(c)(8) now provides an

exception that would change the outcome. See supra note 5.
 12

[*12] treated as effectively connected”, 11 while under section
864(c)(4)(A), “no income . . . from sources without the United States shall
be treated as effectively connected”. And under section 865(a)(2),
“income from the sale of personal property [such as a partnership
interest] . . . by a nonresident [such as Ms. Rawat] shall be sourced
outside the United States”. Ms. Rawat prevails unless some other
statutory provision creates an exception to these generalities, and we
conclude that there is such an exception, as we now explain.

2. The exception of section 751

Section 741, the starting point of our summary above, does indeed
provide that gain or loss on a partner’s sale of her partnership interest
“shall be considered as gain or loss from the sale or exchange of a
[singular] capital asset”—a provision critical to Ms. Rawat’s
contention—but the Commissioner urges the express exception that
immediately follows in section 741, i.e., “except as otherwise provided in
section 751”. That referenced section 751 provides:

(a) Sale or exchange of interest in partnership.—The
amount of any money, or the fair market value of any
property, received by a transferor partner in exchange for
all or a part of his interest in the partnership attributable
to—
(1) unrealized receivables of the partnership,
or
(2) inventory items [plural] of the partnership,
shall be considered as an amount realized from the sale or
exchange of property other than a capital asset.

(Emphasis added.) The Commissioner argues, and we agree, that the
general approach of section 741, which calls for the sold partnership
interest to be analyzed not asset-by-asset but rather as a singular
“capital asset”, gives way to the specific provision in section 751(a)(2)
that the portion of the sold partnership interest attributable to

11 In the quotation of section 864(c)(3) in text above, we elide the parenthetical

qualifier “(other than income, gain, or loss to which paragraph (2) applies)”, because it
is not relevant here. Section 864(c)(2) makes special provision for “Periodical, etc.,
income”—i.e., income “of the types described in section 871(a)(1), section 871(h),
section 881(a), or section 881(c)”; and sections 871(a)(1) and 881(a)(1) both define this
income as “interest . . . , dividends, rents, salaries, wages, premiums, annuities,
compensations, remunerations, emoluments, and other fixed or determinable annual
or periodical gains, profits, and income.” (Emphasis added.)
 13

[*13] inventory items must be separately “considered” as pertaining to
“other than a capital asset”. Consequently, our analysis cannot end with
her “most important” point (that she actually sold not inventory but a
partnership interest) but must proceed to ask: What is the “property
other than a capital asset” from which the “money . . . received” is
“considered” to have been “realized” under section 751(a)? The only
answers suggested in the statute are “unrealized receivables” and,
pertinent to this case, “inventory items”. Therefore, in the vocabulary
of section 751(a), the Inventory Gain is “attributable to inventory” and
is “considered” to have been “realized from the sale” of “inventory items”.

3. Sections 741 and 751 as non-sourcing rules

a. The interaction of sections 741 and 751

Ms. Rawat contends, however, that this argument makes an
unwarranted use of section 751. She notes that the issue in this case is
the source (U.S. or non-U.S.) of the proceeds, and she asserts that
“[s]ection 751 is not a sourcing rule”. In her view, the effect of
section 751, where it applies, is to assure that the proceeds of a sale will
take on the character (non-capital) of “property other than a capital
asset” and will therefore be taxed—if at all—as ordinary income, not
capital gain. Her assertions are not wrong, as far as they go. She is
correct that section 751 is not a sourcing rule—but neither is section 741
(as she acknowledges). Where it applies, section 741 assures that
proceeds on the sale of a partnership interest will be taxed—if at all—
as gain arising from the sale of a capital asset. Both sections 741 and
751 are provisions that define the character of the property sold and of
its proceeds, to which the sourcing rules must then be applied.

The reason that we know to treat the sale of a partnership
interest as “the sale . . . of a [singular] capital asset” (as Ms. Rawat
contends) is that section 741 so provides, imposing (where it applies) the
“entity” theory on such sales. The proceeds of the sale are to be
“considered as gain or loss from” such a sale. It is because of section 741
that the sale of a partnership interest is “considered as” the sale of a
singular asset. Without section 741, we might instead invoke the
aggregate character of the partnership and treat the selling partner as
if, like a sole proprietor, she had sold her proportionate share of the
 14

[*14] underlying hotchpot of partnership assets; but section 741, where
it applies, precludes that aggregation approach. 12

However, to tautologize, section 741 applies only where it applies.
As we have noted, section 741 has an explicit exception: “except as
otherwise provided in section 751 (relating to unrealized receivables and
inventory items).” Section 751 provides that the “inventory items”
portion of proceeds “shall be considered as an amount realized from the
sale or exchange of property other than a capital asset”. Section 741, by
its own terms, does not apply to the “inventory items” portion addressed
by section 751, to which section 741 yields. The singular “capital asset”
treatment of section 741 is thus partially disaggregated by section 751.

b. The differences of sections 741 and 751

Moreover, Ms. Rawat’s view—confining the effect of
section 751(a) to the assuring of non-capital treatment—does not give
sufficient attention to the different wording of the two statutes.
Section 741 provides that in general the proceeds—

shall be considered as gain or loss from the sale or exchange
of a capital asset.

(Emphasis added.) But the exception in section 751(a) provides that the
proceeds attributable to inventory—

shall be considered as an amount realized from the sale or
exchange of property other than a capital asset.

12 Ms. Rawat’s argument—that sections 741 and 751 merely determine the
character (capital vs. ordinary) of a partner’s gain or loss from the sale of a partnership
interest—proves too much. Accepting her constricted view of sections 741 and 751
would undermine the rationale of Grecian Magnesite, on whose holding she depends.
In Grecian Magnesite we construed section 741 as not only determining the character
of gain or loss but also as identifying (subject to section 751 and other express statutory
exceptions) the property involved in the transaction (i.e., “an interest in a partnership”
as opposed to a proportionate share of partnership assets). And we accepted that the
construct reflected in sections 741 and 751 (again, in the absence of express statutory
exceptions, such as the one provided in section 897(g)) governed generally the tax
consequences of a sale of a partnership interest. Petitioner’s position, resting on the
view that sections 741 and 751 have a more limited scope than we gave them in Grecian
Magnesite, is an implicit claim that our decision in Grecian Magnesite was right for the
wrong reasons. But petitioner offers no alternative rationale (from subchapter N or
otherwise) to justify the result in Grecian Magnesite nor to salvage its holding that is
critical to her argument.
 15

[*15] (Emphasis added.) That is, the general rule refers to gain or loss
from the sale of a singular “asset”, § 741, whereas the exception refers
to an amount realized from the sale of “property”. This difference in the
wording of these two statutes tends against Ms. Rawat’s assumption
that section 751 inherits the “entity” approach of section 741.

As we have noted, section 741 posits gain or loss from the sale of
a singular “capital asset”. It is the singular “asset” that signals that the
partnership interest, and not the partnership’s underlying (plural)
assets, is the subject of the sale. The exception in section 751(a),
however, posits an amount realized from the sale of “property” (i.e.,
“property other than a capital asset”). The word “asset” is necessarily
singular, but the word “property” can mean “a thing or things owned;
possessions collectively”. Property, Webster’s New World College
Dictionary (4th ed. 2008). 13 One’s “property” may consist of many
“assets”. If the drafters of sections 741 and 751 had intended section
751 to reflect the same “entity” approach reflected in section 741, they
could perhaps have worded section 751 to provide (in a manner
corresponding to section 741) that the inventory portion of proceeds
“shall be considered as gain or loss from the sale or exchange of a non-
capital asset”. But they did not.

In Grecian Magnesite and in this case we give a close reading to
section 741 and ascribe significance to “asset”. This close reading
benefits Ms. Rawat in the analysis of her Non-Inventory Gain. Turning
then to section 751, we do not relax, take a casual view, and assume that
the chosen wording—“property other than a capital asset”—was a
random circumlocution. Rather, we observe that the drafters chose a
word—“property”—that may stand for one asset or many assets. That
being so, we note that when inventory is involved, the sale proceeds
attributable to inventory are considered to have been realized from the
sale of multiple assets.

In support of this broader understanding of section 751, the
Commissioner cites George Edward Quick Trust v. Commissioner, 54

13 To the same effect, the second definition of “property” in the Oxford English

Dictionary (1933) is “[t]hat which one owns; a thing or things belonging to or owned by
some person or persons; a possession (usually material), or possessions collectively;
one’s wealth or goods”.
 16

[*16] T.C. 1336 (1970), aff’d per curiam, 444 F.2d 90 (8th Cir. 1971), 14
and Mingo v. Commissioner, T.C. Memo. 2013-149, aff’d, 773 F.3d 629
(5th Cir. 2014), 15 and he aptly quotes, Doc. 53 at 35, our opinion in
Grecian Magnesite, 149 T.C. at 78 n.16, which states:

Section 751 is a specific exception to section 741 that
causes unrealized receivables and inventory items to be
addressed separately from the remainder of the
partnership interest when that interest is sold or
liquidated. . . . We note that by the express terms of section
741, section 751 is (like section 897(g) . . .) an exception,
and it mandates an “aggregation” approach for
characterizing only gain “attributable to” “unrealized
receivables” or “inventory items”.

(Emphasis added.) To the same effect, and perhaps even more explicitly
on point, our opinion in Grecian Magnesite, 149 T.C. at 79, characterized
section 751 as one of the “exceptions to section 741 that, when they
apply, do require that we look through the partnership to the underlying
assets and deem such a sale as the sale of separate interests in each asset
owned by the partnership.” (Emphasis added.)

That is, governed in the Inventory Gain analysis not by
section 741 but instead by section 751, “we look through the partnership
to the underlying assets and deem such a sale as the sale of separate
interests in each asset”. Grecian Magnesite, 149 T.C. at 79 (emphasis
added). Deeming a sale of the inventory is called for by section 751
(which “consider[s]” the proceeds to be “realized from the sale . . . of
property”, not of the partnership interest per se). Deeming a sale is

14 As the Commissioner describes Quick Trust, see Doc. 53 at 37, it “addressed
the treatment of an interest in a partnership that held unrealized receivables.” That
“treatment” was an effect on tax “basis” under section 1014(c) of an inherited
partnership interest as affected by section 691 (concerning “income in respect of
decedents”). Quick Trust is thus an instance in which the Court cited section 751 not
only as governing the character of income as capital or ordinary (as Ms. Rawat would
limit section 751) but also as warranting, for other tax purposes, the division of a
partnership interest into different pieces.
15 In Mingo, T.C. Memo. 2013-149, at *11, we held that “the portion of gain

attributable to section 751 property in the sale or exchange of a partnership [interest]
may only be reported under the installment method to the extent that income realized
on a direct sale of such property would be reportable under the installment method.”
The Commissioner correctly characterizes Mingo as “another example of the
application of collateral consequences of the deemed transactions under the section
751 regulations”. Doc. 77 at 5.
 17

[*17] likewise called for by equivalent text in the subparagraph of the
implementing regulation, Treasury Regulation § 1.751-1(a)(1), that
provides (as its caption indicates) for the “Character of amount
realized”. 16 Deeming a sale is consistent also with the subsequent
subparagraph (entitled “Determination of gain or loss”), which provides:

The income or loss realized by a partner upon the sale or
exchange of its interest in section 751 property is the
amount of income or loss from section 751 property . . . that
would have been allocated to the partner (to the extent
attributable to the partnership interest sold or exchanged)
if the partnership had sold all of its property in a fully
taxable transaction for cash in an amount equal to the fair
market value of such property . . . immediately prior to the
partner’s transfer of the interest in the partnership.

Treas. Reg. § 1.751-1(a)(2) (emphasis added). That is, both the
subparagraph that characterizes the transaction and its “amount
realized” and the subparagraph that determines the “gain or loss” from
that amount hypothesize a sale of the inventory to which the proceeds
was attributable.

Admittedly, section 751 and Treasury Regulation § 1.751-1(a)(1)
do not tell us the source of the proceeds nor their effective connection to
a U.S. business; rather, they tell us the nature of the property considered
to have been sold and the nature of the income that is to be taxed (or
not). To find the sourcing rules and their effect on the nonresident
alien’s liability, we look elsewhere.

B. Sourcing the proceeds

The sourcing rules are given in sections 861–865. Section 865
(entitled “Source rules for personal property sales”) provides in part as
follows:

(a) General rule.—Except as otherwise provided in
this section, income from the sale of personal property—
(1) by a United States resident shall be
sourced in the United States, or

16 Treasury Regulation § 1.751-1(a)(1) bears the caption “Character of amount

realized” and, like section 751, provides that proceeds attributable to inventory are
“considered as an amount realized from the sale or exchange of property other than a
capital asset”.
 18

[*18] (2) by a nonresident shall be sourced outside
the United States.
(b) Exception for inventory property.—In the case of
income derived from the sale of inventory property—
(1) this section shall not apply, and
(2) such income shall be sourced under the
rules of sections 861(a)(6), 862(a)(6), and 863.

There is no dispute that the “General rule” of subsection (a)
applies to the Non-Inventory Gain and sources it “outside the United
States”. But see § 864(c)(8) (covering sales on or after November 27,
2017). Section 741 provides the character of the partnership interest
sold (i.e., “a capital asset”), and section 865(a)(2) dictates its source
(“outside the United States”). The Commissioner has conceded that
Ms. Rawat is not taxable on that Non-Inventory Gain portion of the
proceeds of her partnership interest. Ms. Rawat would have us apply
this non-U.S. source “General rule” of section 865(a)(2) to the Inventory
Gain as well and thereby avoid the “Exception” of section 865(b) (and its
incorporation of the more complicated “rules of sections 861(a)(6),
862(a)(6), and 863”).

As to that Inventory Gain, however, we have held that this
portion of the proceeds is excepted from section 741 and that, under
section 751(a), this portion is “attributable to . . . inventory items”. For
that reason we cannot follow the general rule of section 865(a) (“sourced
outside the United States”) but must instead follow the “Exception for
inventory property” that is provided in subsection (b) of section 865 for
“income derived from the sale of inventory property”.

As quoted above, that subsection—section 865(b)—directs us to
find the sourcing rules for the Inventory Gain in the provisions of
“sections 861(a)(6), 862(a)(6), and 863”, 17 and those three sections
provide in relevant part as follows (emphasis added):

Sec. 861(a). Gross income from sources within
United States.—The following items of gross income shall
be treated as income from sources within the United States:

17 Each of these three statutes makes provision as to “inventory property

(within the meaning of section 865(i)(1))”, and we elide the parenthetical in our
quotations in text. Section 865(i)(1) provides: “The term ‘inventory property’ means
personal property described in paragraph (1) of section 1221(a)”; and section 1221(a)(1)
 19

[*19] ....

(6) Sale or exchange of inventory property.—
Gains, profits, and income derived from the
purchase of inventory property . . . without the
United States (other than within a possession of the
United States) and its sale or exchange within the
United States.

Sec. 862(a). Gross income from sources without
United States.—The following items of gross income shall
be treated as income from sources without the United
States:

....

(6) gains, profits, and income derived from the
purchase of inventory property . . . within the United
States and its sale or exchange without the United
States;

Sec. 863(b). . . . Gains, profits, and income—

....

(2) from the sale or exchange of inventory
property . . . produced (in whole or in part) by the
taxpayer within and sold or exchanged without the
United States, or produced (in whole or in part) by
the taxpayer without and sold or exchanged within
the United States, or

(3) derived from the purchase of inventory
property . . . within a possession of the United States
and its sale or exchange within the United States,

shall be treated as derived partly from sources within and
partly from sources without the United States.

in turn specifies “stock in trade of the taxpayer or other property of a kind which would
properly be included in the inventory of the taxpayer if on hand at the close of the
taxable year, or property held by the taxpayer primarily for sale to customers in the
ordinary course of his trade or business”. The parties have suggested no dispute that
the Inventory Gain at issue is attributable to “inventory property” so defined.
 20

[*20] We need not parse these statutes further than to observe that they
provide the sourcing rules for—

• “income derived from the . . . [sale] of inventory property”,
§§ 861(a)(6), 862(a)(6);

• “income . . . from the sale . . . of inventory property”,
§ 863(b)(2); and

• income “derived from the . . . [sale] of inventory property”,
§ 863(b)(3).

We think these phrases, like the similar phrase in section 865(b)—
“income derived from the sale of inventory property”—describe the
Inventory Gain, which, under section 751(a), is “attributable to . . .
inventory items” and is “considered as an amount realized from the sale
or exchange of property other than a capital asset.” Consequently, since
Ms. Rawat’s motion is based on her contention, which we reject, that the
sourcing rule for the Inventory Gain is the general rule of
section 865(a)(2), we will deny her motion.

Despite our rejection of Ms. Rawat’s principal contention about
the effects of sections 741 and 751 and her reliance on the default
sourcing rule of section 865(a), she might nonetheless prevail in whole
or in part by showing, pursuant to section 865(b), that the source of the
Inventory Gain was “without the United States” under
sections 861(a)(6), 862(a)(6), and 863. In the pending motion, however,
she has not attempted to make that showing.

To reflect the foregoing,

An appropriate order will be issued.